Justify the need for regulation of financial markets

• Market failure;• when the market’s pricing mechanism is

incapable of maintaining all the requirements of a competitive, efficient market.

• Regulation restricts financial institutions’ activities in the vital areas of lending, borrowing and funding.

What are the purposes of regulation?

• It prevents issuers of securities from defrauding investors;

• It promotes competition and fairness in trading;• It promotes the stability of financial institutions; • It restricts the activities of foreign concerns in

domestic markets and institutions; • It controls the level of economic activity.

What is disclosure regulation?

• It is the form of regulation that requires issuers of securities to make public a large amount of financial information to investors.

• This addresses the problem of asymmetric information and the problem of agency.

State two main acts which led to deregulation in the early 1980s.

• Depository Institutions Deregulation and Monetary Control Act of 1980 (DIDMCA);

• Garn-St. Germain Act of 1982.

Briefly identify main points of these acts. (DIDMCA)

• The Depository Institutions Deregulation and Monetary Control Act of 1980 phased out Regulation Q interest rate ceilings and expanded the asset and liability options for banks and thrifts.

• All depository institutions were allowed to offer interest-bearing checkable deposits;

• S&Ls and savings banks were allowed to make business loans.

• expanded the powers of the Fed by authorizing uniform and universal reserve requirements.

The Garn-St. Germain Depository Institutions Act of 1982

• allowed all depository institutions to offer money market deposit accounts, which had no interest rate ceilings;

• permitted limited check writing, and were fully insured up to $100,000;

• Super NOW accounts were authorized, which are checking accounts with a high minimum balance that pay a market interest rate.

Why does The Gramm-Leach-Bliley Act (GLBA) of 1999 take a special place in US

regulation?• The Gramm-Leach Bliley Act (GLBA) of 1999 allowed

for bank holding companies• to be certified as financial holding companies (FHCs),

which could engage in many previously barred activities, including securities underwriting and dealing, and insurance and merchant banking activities.

• The GLBA also allowed FHCs to engage in other financial activities and complementary nonfinancial activities.

Why does The Gramm-Leach-Bliley Act (GLBA) of 1999 take a special place in US

regulation?• Banks had previously found ways into the securities

industry through bank holding company subsidiaries. They have been able to do this because the Fed had relaxed or weakened many of the provisions of Glass-Steagall Act.

• With the passage of the Gramm-Leach-Bliley Act (GLBA) in 1999, the final vestiges of the Glass-Steagall Act separating investment and commercial banking were removed.

• The stage was set for full financial integration of the banking, securities, and insurance industries.

Identify the major contractual-type Financial Intermediaries (FIs).

• Contractual-type FIs have liabilities that are defined by contract. They call for regular payments to be made to these FIs in exchange for future payments under specified conditions. (2 marks)

What are their main sources of funds (liabilities) and their main uses of funds (assets)? (FI)

• Three main types of contractual-type FIs are life insurance companies, pension funds, and property and casualty companies. (1 mark)

• Each taps different sources of funds and uses them to purchase different types of financial assets.

• Life insurance companies collect life insurance premium payments and use these funds to purchase corporate and foreign bonds, corporate equities, and other financial assets. (2 marks)

There is a trend toward greater integration of financial markets throughout the world. Provide three most likely causes that lead to this integration. • The three strong arguments include:• Deregulation and/or liberalization of financial

markets to permit greater participants from other countries;

• Technological innovations to provide globally-available information and to speed transactions;

• Institutionalization – financial institutions are better to diversify portfolio and exploit mis-pricing than the individuals;

Compare briefly the use of securities in financial markets and indicate its significance to investors

and borrowers

• Money market and capital market• Primary market and secondary market• Domestic market and secondary market• National market and Euromarket

• 1) investors concern – more liquidity, appreciate more risk and return;

• 2)Borrowers concern – provides liquid funds direct to the initial issuer of securities in primary market, similarly in secondary market – liquidity;

• 3)Investors concern – change in monetary policies in domestic market, change in host country’s economic, political policies affecting price of securities; - both markets affects price risk of securities

National market and Euromarket

• In a national market, securities are traded in only one country and are subject to rules of that country;

• In the Euromarket, securities are issued outside the jurisdiction of any single country;

• Eurodollars are dollar-dominated financial instruments issued outside the US;

• For investors in Euromarkets the diversification is improved;

• Euromarkets are with little or no regulation for borrowers or investors - players are with good credit standings;

Which Act separated commercial banking, investment banking and insurance into three separate industries?

• Glass-Steagall Act• Bank Holding Act• McFadden Act• Federal Reserve Act• Competitive Equality Banking Act• Answer: a

Which Act limited the activities a company could engage in if it owned a bank?

• Federal Reserve Act• Bank Holding Act• McFadden Act• Glass-Steagall Act• Competitive Equality Banking Act• Answer: b

A primary purpose of maintaining the safety and soundness of banks is to:

• encourage loan growth.• protect depositors.• ensure liquidity for the stock market.• prevent discrimination.• minimize bank losses.• Answer: b

Which of the following institutions’ customers have a “common bond”?

• credit union• commercial bank• mortgage company• savings bank• thrift• Answer: a

Which of the following is considered a non-depository financial institution?

• savings bank• mutual fund• commercial bank• credit union• thrift• Answer: b

Which of the following is considered a depository financial institution?

• mortgage company• mutual fund• savings and loan associations• Federal Reserve• insurance company• Answer: c

Originally, the FDIC insured deposits up to:

• $100,000• $50,000• $25,000• $10,000• $5,000• Answer: e

Which of the following is not one of the fundamental forces that have transformed modern financial markets and

institutions?

• financial innovation• deregulation• decreased competition• securitization• changes in technology• Answer: c

Bank regulations:

• can prevent bank failures.• can eliminate economic risk for banks.• Serve as guidelines for sound operating

policies.• guarantee bankers will make sound

management decisions.• guarantee bankers act in an ethical manner.• Answer: c

Which of the following is not a fundamental function of the Federal Reserve?

• Conduct the nation’s monetary policy.• Provide an effective payments system.• Regulate banking operations.• Ensure bank profitability.• All of the above are fundamental functions of

the Federal Reserve.• Answer: d

The reason some individual states restricted bank branching was to:

• encourage the formation of one-bank holding companies.

• prevent outside funds from financing community growth.

• prevent the formation of multi-bank holding companies

• help keep deposits in local communities.• encourage diversification in local banks.• Answer: d

A bank holding company’s income is derived from:

• dividends from bank subsidiaries.• dividends from non-bank subsidiaries.• interest from subsidiaries.• All of the above.• a. and c. only.• Answer: d

Securitization is the process of:

• increasing security at banks.• underwriting municipal securities.• converting bank deposits to Treasury securities.• converting bank assets into marketable

securities.• converting bank liabilities into marketable

securities.• Answer: d